chapter two：time value of money and term structure of interest

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1、CHAPTERTWO：TimeValueofMoneyandTermStructureofInterestCHAPTERTWO:TimeValueofMoneyandTermStructureofInterestYes!istheexpectedrateofreturn,i1>.e.,themeanofthediscountratesfordifferenttermsLetNo!isthediscountratethatcannotbeusedforsolongperiod?DiscountedCash

2、FlowFormulaTermStructureofInterestRatesOurobjectiveistovaluerisklesscashflows.Giventherichsetoffixed-incomesecuritiestradedinthemarket,theirpricesprovidetheinformationneededtovaluerisklesscashflowsathand.FormsofInterestRatesInthismarket,thisinformationon

3、thetimevalueofmoneyisgiveninseveraldifferentforms:SpotinterestratesPriceofdiscountbonds(e.g.,zero-couponbondsandSTRIPS)PricesofcouponbondsYield-to-maturity(anaverageofspotinterestrates)ForwardinterestratesTheforminwhichthisinformationisexpresseddependson

4、theparticularmarket.DeterminationofInterestRateCapitalproductionability——themorethecapital’sexpectedreturn,thehighertheinterestratesandviceversa.Uncertaintyofcapitalproductionability——themoretheuncertainty,thehighertheriskpremiumrequiredandthehigherthein

5、terestratesandviceversa.Timepreferenceofconsumption——thestrongerpreferencetocurrentconsumption,thehighertheriskpremiumrequiredandthehighertheinterestratesandviceversa.Riskaversion——themoretheriskaversion,thehighertheriskpremiumrequiredandthelowertherisk-

6、freeinterestrates.FourbasicfactorsTheoryofRealInterestRatesRealinterestratesaredeterminedbysupplyanddemandoffundsintheeconomy.3factorsindeterminingrealinterestrates:AggregateendowmentsAggregateinvestmentopportunitiesAggregatepreferencesfordifferentconsum

7、ptionpathConsiderarepresentativeinvestor:Hasendowmentof(e0,e7><1)Facesabondmarketwithinterestrater.Hemaximizeshisutilityoverhisconsumptionnowandlater:Wherebisthebondholding,u’>0andu”<0TheoptimalityconditionisRelativeriskaversioncoefficientThus,ther

8、ealinterestrateisgivenbyNonlineartechnologyTime0Time<1-(<1+RC)Investmentopportunitysetbb(<1+r)LineartechnologyTime0Time<1b(<1+r)b-(<1+RC)Moregenerally,considerconsumptiongrowatrandomrate.Investorsmaximizetheirexpectedutili